How to spot a dodgy investment

Commentary: These not-so-obvious conditions may mean danger

In the past decade of writing about stupid investments, one question I was asked most often by readers: “How do I become a smart investor?”

I can answer that question for average investors in three sentences, totaling just eight words.

Jaffe: Here's some really stupid investments

(4:22)

In nearly ten years of writing an investment column, Chuck Jaffe has seen some bad investment idea. He joins Markets Hub with a look at the worst of the worst. Photo: Getty Images.

Know yourself. Understand what you’re buying. Be careful.

Follow those instructions and it’s hard to make big investment mistakes.

The second most asked question was tougher to answer, because it was about what a stupid investment looks like, or how to spot one. There’s something of an art to this. Two years ago at a big industry conference, I told a friend I was hunting for column fodder and he asked how I would decide. I told him I would wander until I smelled it, and stop when I stepped in it.

Today, I want to leave you with an enhanced sense of smell.

Since early in 2003, Stupid Investment of the Week has examined the conditions and characteristics that lead average investors to choices that are “less than ideal.” Since no one sets out to make poor decisions and buy something lousy, the idea here typically was to deconstruct the case for purchasing an investment, highlighting its potential to go wrong. (And I will continue writing about bad investments/judgment, but without the constraints imposed by the SIOTW format.)

Bad investments — and the problems that lead to them — aren’t going anywhere. The investments examined over the last decade ranged from good companies that, for a time, were bad stocks to inherently, irrevocably flawed investment products and seemingly everything in between. While more than 20% of the investments covered are gone by now, some live on, and probably will forever, kind of like investment cockroaches, always there to feed on those who are sloppy in their financial housekeeping; for every stupid investment that disappeared, there has been at least one new concept or issue that filled the void.

While not every bad investment idea comes with high-flying red flags, there are some conditions that routinely come up that should be an indication that you’re headed into the danger zone. Read The stinker investment sniff test

High costs

The harder it is to make money after you pay the freight, the more likely you’ve got a poor investment choice. That’s not to say some mutual funds, insurance policies and other securities can’t overcome costs, but most don’t, especially over long periods of time.

Investors must recognize that there is no free lunch; one way or another — whether the costs are out in the open or hidden and buried amid complex details -- you’re the one paying the costs, and no one would sell it to you if they couldn’t make something on the deal.

Mass-market appeal

It’s not that appealing to a wide audience is bad, but it doesn’t necessarily lead to great investment products, and consumers often can get a better deal just by putting a little individual effort into it.

For example, most insurance policies pitched on television — the ones that promise coverage with no questions asked -- are priced as if the buyer already has one foot in the grave. If you are otherwise uninsurable, that might be okay, but the vast majority of people buying these policies could get more coverage, pay lower premiums or both simply by not jumping in with the crowd.

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